The 2022 Bear is Official

It’s official – the S&P 500 stock index is in bear market territory. A bear market is defined as a 20% drop “from most recent peak to trough.” The peak was January 3rd. The 20% trough was reached last Monday, June 13th, thus triggering what we’ve felt all along – that it’s been a tough go for investors in 2022. Nearly all global asset classes are down double-digits year to date, some much more than others (i.e., cryptocurrencies and tech/growth stocks). And while Bonds normally play the cushioning role in a portfolio, even they have declined markedly this year.

We know the contributing reasons why: higher inflation, war in Ukraine, post-pandemic supply chain imbalances, supply-chain imbalances, prices of oil, gas, food, housing, Fed policy, fiscal policy, China, interest rates, P/E multiples, consumer sentiment, etc. The list goes on. Certainly, all these things play a role. But to some extent, none of this should matter much to long-term investors. We know that financial returns do not come without risk, risk is always present somewhere. Bull and bear markets are a normal (if painful), healthy outcome of well-functioning economies, but they do end eventually. Ed’s recent client note (“This Time is Different?”) explained how history never exactly repeats, but it usually rhymes. In this note we’ll provide some historical context about bear markets and their ability to predict what may happen next.

First some historical statistics. There have been, give or take, 15 bear markets for the S&P 500 since 1950, not counting this current bear^1,2. The average decline from peak to trough has been ~33% (with declines ranging from ~20% to ~57%), taking on average about 1 year to arrive at the bottom. Getting back to break-even has taken on average 1.8 years, ranging from the short-lived bears of 1980-82 and 1998 (~1 quarter), to the long-running bears of 1973-74 and 2000-02 (~5 years). These are historical statistics, only known in hindsight. Experiencing any one of these bear markets in real time certainly weighs on investor psychology.

Most recent in all our memories is the COVID-19 bear market of 2020, falling 33% in about as many days beginning in late February of that year, and taking only 6 months to recover from the lows. While there is some evidence pointing out that our bear/bull cycles have been more extreme and faster in recent years, the truth is we have no way of knowing how this current bear will play out and what it portends.

We could already have hit the bottom as the Fed attempts to engineer a “soft landing” to cool inflation and avoid a recession. Or this bear market could be only halfway (or less?) to the bottom if the Fed over/under reacts and inadvertently drives the economy into recession in the coming months. We just don’t know. Therefore, the best course of action for long-term investors remains: Don’t panic; Keep a good handle on your emotions; Remain disciplined and patient and stick to your well-diversified investment plan through down and up markets; And know that the vast body of research shows that stocks outperform all other asset classes over the long run. Younger investors should view bear markets as buying opportunities, whereas investors nearer to, or in, retirement likely already have plans that balance the risk and return needed to support their goals.

On the brighter side, expected future returns of both stocks and bonds are now higher. Stock valuations (as measured by the P/E ratio of next year’s earnings) have come back down to 16x, closer to historical averages. The US Aggregate Bond Index (“the AGG”) is yielding now 3.85%, whereas for much of the past few years it was yielding below zero. Remember, too, that markets are forward-looking. While markets are currently gloomy as they adjust to a new macroeconomic landscape and fears of recession, they also typically begin to rise earlier than the economy rebounds as new data are released and digested. Historical data³ has shown that 1 year after the S&P 500 crossed into bear market territory (i.e., 20% fall from the previous peak), it rebounded by about 22% on average. And after five years, the S&P 500 averaged returns over 70%.

As Warren Buffet remarked in his 1987 annual letter to Berkshire Hathaway shareholders, refining a point made by Benjamin Graham and David Dodd from the 1930s, “In the short run, the stock market is a voting machine. Yet, in the long run, it is a weighing machine.” What he is referring to is that what matters in the long-run is a company's (or in the macro sense, an economy’s or a market’s) underlying business performance and not the investing public's easily changed sentiment about short-term prospects and narratives.  

This bear too shall pass. Your future self will thank you for remaining invested.

Thanks for reading.

 - Mike

End notes.

1. While technically speaking the definition of a bear market is a 20% decline peak to trough, living through markets that decline 19% feels just about the same. So, the dataset referenced here from Ben Carlson, “A Wealth of Common Sense”, includes a few 19% declines for good measure.
2. Additional sources: New York Times; Refinitiv; Yardeni Research; New York Times analysis of S&P 500 data; Federal Reserve Bank of St. Louis
3. Dimensional Funds Advisors, “Three Crucial Lessons for Weathering the Stock Market’s Storm”, June 17, 2022.